Is selling a financial planning practice to an outsider the best way to extract its true value?

If you are growing your practice, one can argue that growth through acquisition is the most efficient method through which to gather client relationships and the underlying client assets-but how does the equation play out for the seller of a financial planning or investment advisory practice? Does an internal succession plan ultimately result in better overall client retention and, as a result, enhance long-term value to the practice's owner?
Since I have grown my own practice through two acquisitions, clearly I am of the opinion that growth through acquisition is a terrific way to build a business. Yet as an advisor's practice reaches a point where extracting the value becomes an integral part of their retirement plan, what is the best strategy to employ?  
Consider the following scenario:
Mr. Smith has worked for the better part of two decades building client relationships and a stream of recurring revenue that now exceeds $500,000 annually. He has reached the point in his life where spending time on the golf course is more appealing than keeping track of the new annual gifting limits; however he is having difficulty peeling himself away from the day-to-day duties associated with running his practice. Launching a simple Internet search on business succession planning, Mr. Smith rapidly learns of two schools of thought that have become popular among financial advisors-sell the business externally or develop an internal transfer plan.
Before I offer viewpoints on the question, let me address a subject of confusion for many advisors related to the choices. Not long ago, one of the industry's service providers introduced the term "transition planning" to supposedly denote the act of selling one's firm to anyone other than an internal buyer. In reality, the term transition planning is used in the business brokerage world only to describe the latter part of a succession plan, when the transition phase is enacted. For example, most any business transfer has the need for a transition of both ownership and management responsibilities to the new owner(s). The term is most applicable to the seller of an advisory firm, in that there is a crucial need to plan for the transitioning of client relationships to the new owner.
In sum, succession planning defines the complete process of preparing and completing all phases of the transfer of a business, whereas transition planning is just a late-stage fragment of the total plan.
So back to the question at hand-does the retiring advisor, Mr. Smith, get to play more golf by executing an internal or external sale?
The succession planning game is not unlike managing an investment portfolio. It is critical to maintain the principal because it is the engine that drives growth and revenue. In the case of a financial planning or investment advisory practice, owning the client relationships is like preserving the principal in an investment portfolio. So long as you maintain the principal, you can live off the growth and revenue it generates.
Perhaps owners of advisory practices are getting that message as fewer and fewer practices are surfacing for sale. In fact, based on's tracking of practices listed for sale during 2005, less than 30 practices came to market during the year. This independent assessment is in direct conflict with the 240 practices as sold during the year cited by Business Transitions LLC in an April 24 Wall Street Journal article, "Demand, Hurdles High to Buy Firms," written by Kristin McNamara. Not only is this disparity disturbing, but it also echoes the concerns many advisors have voiced over conflicting data Business Transitions LLC has reported in its Practice Transitions Report over the last four years.
If 240 practices really were sold by Business Transitions during 2005, how did, an independent service that tracks all financial advisory firms for sale through established market channels, miss seeing nearly 90% of these sales? Furthermore, if historical sales data displayed on Business Transitions' Web sites are similarly overstated (sales dates are undisclosed, making this difficult to verify), then the advisory industry has been seriously mislead as to the actual number of advisors who have chosen to sell their practices externally versus internally. It seems to me that an independent audit of the Business Transitions data published in their marketing booklets may be necessary for those of us in the industry to remain confident in their statistics.   
Regardless of the controversy, other credible sources report a different picture. These include a 2004 Financial Planning Association (FPA) study performed by Moss Adams LLP where only 2% of participants had sold either part or their entire firm in the previous year. Additionally, a 2005 study cited in the second edition of another FPA publication, Succession Planning Strategies for the Financial Planner, shows very few of today's planners consider the sale of their practice to an outsider to be a viable option for succession. The study, available at, indicates that 66% of the respondents plan to facilitate an internal succession. Incidentally, the author of Succession Planning Strategies, David K. Goad, ChFC, of Succession Planning Consultants (SPC) in Newport Beach, Calif., was the founder and CEO of Business Transitions until selling his majority ownership to the current owners in 2002.
It appears to me that advisors with an eye on retirement have gotten smarter and are now protecting the coveted revenue-producing asset they have worked so hard to build. By hiring an experienced advisor with a proven business track record or by mentoring an advisor already on staff (or in the industry) with the proper attitude, skill set and business acumen, a retiring advisor often can extract far more value than if he were to sell his business externally. The major benefit is the ability to extract that value long into retirement while providing seamless service to the firm's most valuable asset-its clients.
With guidance from Goad, let's do some math based on Mr. Smith's practice, as discussed earlier, to see how the numbers work out. Let's assume the value of Mr. Smith's practice based on the net operating profit valuation method1 is $1,000,000. In the Figure 1, let's assume that Mr. Smith sells his practice tomorrow to an outsider and further assume a profit margin of 40% on the $500,000 gross recurring revenue stream net of Mr. Smith's $100,000 salary.
FiIt's important to keep in mind that Mr. Smith is essentially now out of business, (an external buyer will require a noncompete agreement), and is assuming a large risk that the revenue stream will continue in the face of potentially volatile markets and a new owner at the helm.
Conversely, should Mr. Smith plan well ahead of when he wants to free up time in his life, he stands to derive much more financial reward and greater flexibility with an internal succession. (Figure 2)
This internal sale example is only a snapshot of the potential value. Since Mr. Smith is maintaining 60% of the firm's stock until full retirement or death, he will likely benefit from many years of additional increasing income and increasing business value. The major benefit of the plan, aside from having flexibility in timing the sale of his remaining 60% stock balance, is that he now has a buy/sell in place for illness or death which, as a solo practitioner, he did not. This of course is all possible by using the power of leverage through the addition of an associate.
If Mr. Smith elects to mentor a successor, and selects and trains that successor carefully, he will have maintained ownership of the engine that drives revenue-the client relationships. True, internal succession involves more work on behalf of the retiring advisor, but by planning ahead and adding an extra year of effort, Mr. Smith will receive more than 2.5 times the value of an external succession plan, or an extra $1,589,700.
So to answer the initial question I raised at the beginning of this article-Is selling a financial planning practice the best way to extract its true value?-I would say absolutely not.

Kristofor R. Behn, CFP, is president and founder of The Fieldstone Financial Management Group, Practice Merger Consultants and Practice Lifecycle, all based in Boston.